By Ben Evans (Economics Correspondent)
Edited by Ollie Lycett (Economics Editor)
The classic debate of ‘tax and spend’ has dominated the Conservative leadership contest over the last few weeks. To some extent this is to be expected, in light of the economic circumstances facing the UK and other nations alike.
As of July 2022, the UK’s national debt is approximately £2.3tn (106% of real GDP), with an estimated interest payment of nearly £100bn a year, after the necessary COVID support schemes throughout the pandemic. In addition to this, the CPI inflation rate has soared to a 40-year-high of 9.6%, and energy bills are expected to rise to £2800 a year in October, and potentially up to £500 a month by January.
In response to the current ‘cost-of-living crisis’, both Rishi Sunak and Liz Truss are largely endorsing neoliberal economic theory, and are trying to frame themselves as the next iterations of Margaret Thatcher. Sunak is advocating for a ‘sound money’ approach, whereas Truss aims to ‘release Britian’s potential’ by pursuing a free-market strategy which appears to be more akin to ‘Reaganomics’. Many fear neither of these approaches are enough to truly deliver the 2019 manifesto pledges of ‘levelling up’ the UK, and achieving ‘Carbon Net-Zero’ by 2050. So with ever more frequent union strike action, potential fears over a global recession, and huge national debt what are the final two candidates proposing, and what real consequences will this have?
Rishi Sunak has to be framed as the economic ‘continuation candidate’ in this race, as he is being forced to defend his high tax legacy as Chancellor since 2020. The approximate cost of the furlough scheme was around £330bn, and COVID also piled many additional costs onto the Treasury with increased healthcare support and excessive wastages. Naturally, after these huge levels of spending, Sunak, a self-described ‘fiscal conservative’, is desperate to balance the books and reduce the national debt. In order to achieve this rapidly, Sunak has pledged to maintain his 15 tax increases whilst in office, inclusive of the 1.25 percentage point rise to National Insurance (to pay for clearing the NHS backlog); an increase in corporation tax on business profits from 19% to 25%; and a ‘stealth tax’ using a phenomena called ‘fiscal drag’. Effectively, Sunak will not increase the income tax thresholds, so as wages rise with inflation, more people will be pushed into higher tax bands, therefore paying a higher percentage of their income in taxation.
Sunak claims that national debt is currently at ‘unsustainable levels’ – a notion which is aligned with basic economic theory, in that it is fundamentally unfeasible for a nation to just keep borrowing indefinitely. Countries that borrow excessively can be forced to ‘default on their debts’, reducing their reliability to future lenders, as was the case in Greece during the ‘debt crisis’ of 2011. However, it should be stated that the UK currently has a lower debt to GDP ratio than Japan, the USA, and Canada, all of whom aren’t raising taxes, so the importance of short term debt reduction is questionable. Rishi Sunak’s other concern is the rising inflation. Despite supply-sided issues being the initial cause (through increased energy prices and global supply chain issues) Sunak fears lowering taxes. As tax cuts allow people to keep more of their money, they’re likely to spend it and increase demand in the economy. With a limited supply of key goods, prices may need to rise to ‘ration’ them out, known as ‘demand-pull’ inflation. His tax rises would keep demand low and prevent this, at the cost of seriously stifling growth. Overall, Sunak is claiming that his proposals would both reduce the debt, and return annual CPI inflation to a healthy 2%.
Such policies are fiscally contractionary, and are likely to cause short-term pain for countless families across Britain, with the capacity of inducing a recession within the year. In the long-run, it does seem more positive. Rishi Sunak has pledged UK ‘energy independence’ by 2045 in an effort to ease our reliance on foreign powers, and is committed to ‘net-zero’ by 2050. Presently, the Tory membership are not convinced, and his opponent Liz Truss has claimed his proposals are part of a ‘failed Treasury Orthodoxy’. So what’s her fresh approach?
Liz Truss is currently favoured by the ‘Right’ of the Conservatives, and therefore her approach caters to the natural ‘laissez-faire’ instincts of the Tory Party. Truss has pledged to dramatically reduce the tax burden through removing both the NI and corporation tax increase; placing a one year suspension to the ‘Green Levy’; and questioning the Bank of England’s control of monetary policy. The effects of her £32bn worth of tax cuts are widely disputed, as are her funding proposals. Truss and her supporters claim that they’re needed to ‘boost’ the UK’s stagnant growth (estimated to be as low as 0.5% in 2023). Her reasoning consists of the usual ‘neo-classical’ arguments, lower taxes reduce the barriers to business investment and allow for more to be spent on growth and innovation by the private sector. Truss claims that her tax cuts, and the removal of all EU regulations by 2023, would increase growth to an extent that tax revenues would also rise. In essence she’s aiming to have a smaller slice of a larger pie. This thinking has been heavily influenced by the ‘Laffer Curve’, an economic theory that claims tax receipts could rise as taxation rates fall due to the increases in economic growth. Thus, reducing debt as a percentage of GDP. In the last decade, forces from both the Left and the Right have critiqued the long-standing economic orthodoxy that ‘austerity’ measures (such as Sunak’s policies) are needed for debt reduction, Truss is proposing that tax decreases are the path to take.
This theory, which supported the reforms of President Reagan in the 1980s, were questioned by many economists, including Thatcher’s own Chancellor Nigel Lawson. Many don’t believe these reforms would create a sufficient level of growth to increase government tax revenues. Currently only one economist has endorsed Truss’ reforms, Patrick Minford, who supported the ‘Leave’ campaign in 2016. In opposition to her plans, the Sunak campaign has stated that her reforms could push inflation up to 13%. This would force the Bank of England to increase interest rates up to 7%, their highest since 1998, and thus potentially negate the short term benefits of her initial tax cuts. Of course these predictions should be taken with a pinch of salt given their source, and when questioned, Truss has pinned inflation on the central bank, blaming the increases to the money supply, as the driver of underlying inflationary pressures. The Federal Reserve’s own research has claimed that these policies have contributed to at least a 3% increase in prices, however, it should also be noted these policies prevented a deepening of the recessions in 2008 and 2020. Liz Truss has promised to scale back the extensive money creation by the Bank of England, which severely threatens its independence guaranteed since 1998.
Both candidates have reached a consensus over certain issues – both want to crack down on trade union freedoms, with minimum service operation times and higher support thresholds for strike action being tabled. Policies that trade union leaders, such as Mick Lynch, have claimed could be met with a ‘General Strike’ in retaliation. Both want to enjoy the ‘Brexit dividend’ of removing VAT on energy bills; both support ‘deregulation zones’ and ‘free ports’; and both claim the other to be a Socialist!
Overall, the emergence of ‘stagflation’ (low growth, and high inflation) has placed the UK in an ‘Economic Catch-22’; a choice between stoking inflation, or a recession. When simplified it can be deemed Truss’ plans would do the former, and Sunak’s plans would do the latter. A choice of pain or danger, a return to austerity, or a leap into an untested economic formula. These are tough economic times, only exacerbated by the Tories’ legacy of underfunded public services and stagnant economic growth. The truth is there isn’t a ‘fix all’ answer to the UK’s troubles, however both these ambitious hopefuls would never admit this undeniable fact.
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